The British American Tobacco (LSE: BATS) share price rose after the FTSE 100 heavyweight reported its 2023 results on 8 February.
I think the 9.5% dividend yield looks safe, but British American Tobacco’s numbers revealed a slightly more mixed picture in other areas.
Is now the right time to consider buying shares in the firm? Here’s what I think.
Out with the old, in with the new!
British American Tobacco has been pushing hard to develop its New Categories business in recent years. This includes Vuse vapes and Velo modern oral pouches.
Sales of New Categories products rose 16% to £3.4bn last year and this division became profitable for the first time – albeit with only a modest £17m contribution to group profits.
Unfortunately, this progress was offset by a big downgrade to the long-term outlook for the company’s main US cigarette brands.
When it acquired control of rival Reynolds American in 2017, the deal gave the group ownership of well-known US cigarette brands such as Camel and Newport.
Management now says that a weaker outlook for the US cigarette market since the pandemic means these brands aren’t worth as much as they used to be.
As a result, it has cut the carrying value of the Reynolds brands from £83bn to £56bn – a drop of £27.3bn.
More interestingly, I think, it now expects these brands to have “a useful economic life not exceeding 30 years”. Previously, they were expected to have an indefinite life.
Should shareholders be worried?
This change shouldn’t affect British American’s near-term cash generation. The group generated £8.3bn of surplus cash last year — enough to cover the £5bn dividend and repay a chunk of debt.
CEO Tadeu Marroco’s guidance for the next five years is that the business will generate £40bn of free cash flow – that’s around £8bn per year.
I think this should continue to support the dividend, but it does suggest that Marroco does not expect to deliver any overall growth in that time.
In reality, I think the long-term future for tobacco in developed markets is always going to be uncertain. Smoking rates are unlikely to rise again, in my view.
Fortunately, British American has another little-known asset it may be able to sell, that could be worth as much as £12bn!
A £12bn windfall?
It’s the largest shareholder in ITC, India’s largest cigarette manufacturer.
ITC is listed on the Indian stock exchange and currently has a market cap of about £51bn. This means that the UK-listed firm’s 23.9% shareholding could be worth around £12bn today.
That’s equivalent to around £5 per British American Tobacco share, or about 20% of the group’s current market capitalisation.
Its shareholding in ITC can be traced back to “the early 1900s” and won’t be simple to untangle. But Marroco says the company is working hard “to give us the flexibility to monetise some of our shareholding”.
A partial sale seems likely to me. This could fund a big shareholder return or cut debt.
Are the shares a buy?
The shares are currently trading on less than seven times forecast earnings for 2024, with a 9.5% dividend yield.
I think the risks are already reflected in the price. In my view, the shares are likely to be a decent buy to consider at current levels.
